THIS IS A RUSH TRANSCRIPT. THIS COPY MAY NOT BE IN ITS FINAL FORM AND MAY BE UPDATED.

CANDY CROWLEY, HOST: It took 18 days to remove a dictator of 30 years. Egypt is a different place now, but in the aftermath of euphoria the question is the same -- what next for Egyptians, for the region and the world, for the U.S.?

The first definition of revolution in the dictionary reads an overthrow or repudiation and the thorough replacement of an established government or political system. Egypt's revolution is just getting started.

After the dictator, we'll talk with our reporters about Egypt under military rule, Washington's next moves with Republican Lindsey Graham from the Senate Armed Services Committee, and the impact on the region with former U.N. Ambassador John Negroponte and former Ambassador to Egypt Edward Walker.

Then the administration's next challenge -- budget cutting. We are joined by the head of the Office of Management and Budget Jacob Lew.

I'm Candy Crowley and this is "State of the Union."

Some breaking news out of Egypt, a military spokesman has just read an announcement with significant developments. The Egyptian military has suspended the constitution and the transition government will run the country for six months or until elections of the parliament. We have two correspondents standing by: Ivan Watson in Cairo and Nic Robertson who had driven to Sharm el-Sheikh, where former President Mubarak is reported to be.

First to you Ivan, can you help translate to us whether you think this sort of action, suspending the constitution, putting a time limit it would seem, on how long the military will stay in control, is that enough to empty the square for weeks to come?

WATSON: The square is mostly empty right now, Candy. The military swept in yesterday and continued today trying to push protesters out, tear down a lot of tents in some cases despite objections from some of the more die-hard demonstrators who have said they do not want to leave until they are 100% confident all demands are met.

I was down there an hour or two ago and actually saw actually the Red Beret military police detaining some demonstrators and small scuffles breaking out. This move is pretty dramatic, because there's been a question in the air, who is in charge. The Prime Minister Ahmed Shafik who you spoke to last week on the phone just made an announcement, but there was no warning that the military was going to announce such sweeping changes, assuming so much responsibility of the state saying that it was going to dissolve parliament, suspend the constitution, be the representative of Egypt both domestically and internationally and oversee the process of trying to set up the next presidential and parliamentary elections.

When it comes to the parliament -- dissolving the parliament, I think the military will have the support of much of the protest movement because the parliament has very little credibility here after the very troubled and widely perceived as rigged election of last November and December -- Candy.

CROWLEY: I may have put the question inartfully. What I'm trying to get as is do you think the moves by the military will be satisfactory to protesters and they will, in fact, stay out of the square, that this is what they wanted, this puts them on the road to where they want to go. Are these good things?

WATSON: I think for the time being many of the demonstrators and protesters are supporting the military and have been working hand in glove in the square, for example, sweeping up debris, repainting the curbs there and you still have hordes of people coming to take photos with the military. The military is riding high now.

But there are from some segments of this really historic opposition movement, this protest movement, are some suspicions and there are some doubts. But I think it's safe to say that the majority of them are kind of in a wait and see mode.

It is important to note outside the square we are seeing protests cropping up around some of the main banks, for example, people demanding higher wages, angry at their bosses, the chairman of those companies arguing that the salaries there are too high. And it is likely we'll continue to see this bubbling ferment of discontent with some of the older institutions in this country that still may be run by people who were very close to the Mubarak regime.

The expectations have been raised very high. And as one demonstrator told me today in the square, we have had a revolution. Mubarak is gone now but we still have the same 80 million problems in this country, meaning the entire population of Egypt.

CROWLEY: Let me turn now to our Nic Robertson. Nic, I know you drove to Sharm el-Sheikh, so you were able some of the countryside. What we have seen for 18 days has been really Tahrir Square and parts of Cairo. Is it any different? As you traveled did anything catch your attention?

ROBERTSON: I think there is a lot of military presence controlling the main checkpoints that go under the tunnel under the Suez Canal -- obviously the Suez Canal is strategically vital to the world. Egypt knows that, the army knows that, and they have put in, from what we can see, very tough and stringent checks either side of that tunnel to make sure that everyone that goes through is identified and has their bags searched.

It does mean there are long delays. But it does mean it would be hard for terrorists to strike underneath the tunnel and damage this vital part of the global transport network or the shipping network.

We also saw driving across the desert, in the Sinai Desert, where it's incredibly remote, Bedouin farmers, more goats and sheep at checkpoints than policemen, but spray painted on the side in the middle of the desert was "go Mubarak." And I think that really gives you an indication that it wasn't just what we were seeing in Tahrir Square but it was across the country that people had the same spirit and feeling that it was time for President Mubarak to step down, Candy.

CROWLEY: Nic, tell me about Mubarak. Are we certain he is in his residence in Sharm el-Sheikh? And is it a given that he can, as he once expressed interest in living out his days in Egypt. Are Egyptians likely to let him live on in peace there?

ROBERTSON: He is -- if you look over my shoulder here, you will see a low white wall some distance behind me there. That is the wall of his presidential compound. It's incredibly tightly guarded at the moment. To get on the road that drives down there, there are police checkpoints, the police have automatic weapons. There are plain clothes security personnel who ask you searching questions about who you are, what you do, where you're going to get down the road that approaches that door. And I can certainly tell you that there are very heavy security installations around and at the moment the government here seems to be providing a high level of security for President Mubarak at this time. It's very close to us here, Candy.

CROWLEY: Nic Robertson in Sharm el-Sheikh, Ivan Watson in Cairo, a salute to both of you. Just such great work. We appreciate your time.

Up next, Republican Senator Lindsay Graham on how the U.S. should handle the revolution in Egypt.

(COMMERCIAL BREAK)

CROWLEY: Joining me now from Greenville, South Carolina, Republican Senator Lindsey Graham. Senator, thank you. I'm not sure if you got to hear the breaking news at the top of the show, but essentially the military council has said that they have suspended the constitution and that they will be conducting things for the next six months or until there are elections.

Is that an OK timeframe, do you think, as far as the way the U.S. is looking at it?

GRAHAM: Well, I think from our national security interests, this election in Egypt is going to define Egypt in the region for decades. And Mr. ElBaradei said it could take up to a year to get democratic institutions in place. Just think what they have to do going forward. There really is no independent judiciary, there are no political parties. The constitution has been used basically to outlaw political parties. So I'm looking for a free, fair, transparent election that would get the full flavor of Egypt. And a rushed election could help an organization like the Muslim Brotherhood, so my advice to the Egyptian people is, take your time, reach out to the world at large. A lot of people want to help you. And I'm not so sure you can do all the things you need to do between now and September to have an election that reflects the full will of the Egyptian people and to create democratic capacity. But that will be up to the Egyptian people.

CROWLEY: I was talking to an administration official yesterday who talked about being -- there being two different clocks in Egypt. And one of them goes slowly, because it says you are building a democracy from the ground up here. That is not easy to do. We saw that in Iraq under entirely different circumstances, but nonetheless, it takes time when every institution needs to be redone.

GRAHAM: Right.

CROWLEY: And then there is that other clock, that is the impatience that you saw in the square, the impatience that you feel from young people and from their parents. And so you have to find that sweet spot, do you not, between going too slowly to satisfy protesters who could just as easily show back up in the square, could they not?

GRAHAM: You know, that is a very good analysis. And I think your network has done an outstanding job of informing the American people what's going on in Egypt.

Yes, where is that sweet spot? There will be a desire to look backward, to hold Mubarak accountable. How much money did he steal from the Egyptian people? Should he and those around him go to jail for abusing the Egyptian people? That's going to create friction with the army, because the army has been very close to Mubarak institutions, the Mubarak presidency.

So as young people, the Muslim Brotherhood talk about looking backward, that may create some friction going forward.

We know what the people are against in Egypt. We don't yet know what they are for, so there is a lot of friction when it comes to capacity building. You know, how much can you get up and running before September to make the election really meaningful? So I would err on the time of going slow, building capacity, and as the desire to look back grows -- which it will, to hold people accountable -- that will create friction among the army because a lot of the generals in this army have lived pretty well during the Mubarak era. And I don't know how much they are going to be into letting people go back and hold him accountable.

CROWLEY: Well, and yet these are also the people who the U.S. has mainly been dealing with.

GRAHAM: Absolutely.

CROWLEY: Certainly during the last 18 days, and obviously over the course of the last three decades.

When you look at the idea of Egypt recreating itself, what do you worry about most? Because I have seen people say, I worry about the U.S. intelligence gathering. Egypt has been so helpful, particularly when it comes to Al Qaida and Iran, what's going on in Gaza. I have had other people say, you know, this was the door to other Arab countries. What worries you most that the U.S. will lose or might lose?

GRAHAM: Well, as we develop a new -- if we can pull this off, if the Egyptian people can create a democracy in the heart of the Arab world, it will be a more significant contribution to civilization than the great pyramids. It really will have a long-lasting effect.

I worry that we'll rush to an election where the Muslim Brotherhood, who is the most organized but doesn't represent the true will of the Egyptian people, will have a disproportionate effect. I worry about the army. Will the army hold together? Will the young officers accept the rule of the senior people? Will the army really subordinate itself to civilian control as this new democracy unfolds?

You talked about intelligence. I worry about our own intelligence services understanding what the heck is going on. When the DNI of the United States says the Muslim Brotherhood is mostly a secular organization, that sent chills up my spine. It makes me wonder, do we really know what's going on in Iran? And if Iran gets a nuclear weapon, all hell breaks loose in the Mideast. So I worry about what happens in the next six months to a year in Egypt affecting our relationship with Saudi Arabia, with Jordan and Israel.

Now is the time to stand by Israel without equivocation and help the people in Egypt to form a democracy. But at the end of the day the order, the task they have chosen will be very difficult but doable.

CROWLEY: And it could backfire.

GRAHAM: Oh, let me tell you, you've got Jordan and Saudi Arabia are thinking we have thrown over our friend in Egypt. Well, Mubarak was a good ally. He did bring a calming influence. The army has reaffirmed the peace treaty with Israel. But at the end of the day, people in Jordan and Egypt -- excuse me, Saudi Arabia, need to get the message from Tunisia and Egypt. And that is that you've got to give your people more say, a larger voice in society.

This could be a good thing for the region or it could all fall apart. If it falls apart in Egypt, who knows where it ends, what kind of forces does it unleash in the Mideast. So you get one chance to get this right.

To the protesters, I know you have had a tremendous effect on the future of Egypt in the last 18 days. My advice would be to go slow, form political parties, take that energy that led to bringing this regime down and chart a brighter future that is based on religious tolerance and secular democracy. And those things are not certain yet, by any means.

CROWLEY: Senator, while Egypt was busy reformulating itself, CPAC, which is the, as you well know, a collection of conservative groups, was holding a meeting in Washington, talking about spending cuts and the like. But they also had a straw poll that I just wanted to show you the results of over the weekend.

Ron Paul came in first with 30 percent. Mitt Romney next with 23 percent. And then down the line, Gary Johnson, Chris Christie and Newt Gingrich. There were others, obviously a lot of others that I'm sure you know personally that are thinking of running for president. Is there anybody on this list that you look at and think, I could go with this guy?

GRAHAM: Well, you know, at the end of the day, I'm looking for the most conservative person who is electable. And that person is yet to emerge. Mitt Romney is probably the frontrunner among traditional candidates. Ron Paul is a well organized, has a lot of energy behind his ideas. But whether or not he could win a general election, I think, is a big if.

We have got a tall task as Republicans. We're going to have to win independent voters. They are very much looking at the Republican Party anew. We are getting a second chance with the American electorate. We did well in 2010. And I think President Obama is beatable, but we have got to nominate someone that can win over independent voters, who do want smaller government and less spending, but understand there is a role for government. So over the next few months, we'll see who can pick that mantle up and run with it, the most electable conservative. No one quite knows yet.

CROWLEY: Up next, we'll get perspective on how the events in Egypt will shape the Middle East with two former ambassadors.

(COMMERCIAL BREAK)

CROWLEY: Joining me now here in Washington, Edward Walker, former U.S. Ambassador to Egypt and Israel during the Clinton administration; John Negroponte, former U.S. Ambassador to the U.N., former deputy Secretary of State under George Bush. So thank you all this is getting familiar here. And I'm so glad we have had you to walk us through what's going on.

The latest is the military communique saying we are going to suspend the constitution and we will be running things for six months or until elections. So translate that. Is it a good thing, a bad thing?

WALKER: It's a necessary thing. Because you can't rebuild until you get rid of the old. If you look through the constitution it's virtually impossible to think how you would reform it to meet demands of the Egyptian people. And so taking it off the table for now and reconstructing it, particularly those elements related to elections and who can run, it's critically important for the next step. So this is a positive step forward.

CROWLEY: Seems to me September sounds kind of early to recreate a democracy. Is there, how long do you think the military has to show to the protesters and the people of Egypt that they are on the path that the protesters want them on?

NEGROPONTE: I think September is a short period of time. I think it's a question of what the trend is, how much progress is being made. I don't think they have to feel bound by a strict deadline. I think the important thing is that they engender enough confidence with the Egyptian people that the Egyptian people think that the military wants the same outcome as they do and that the military just isn't acting according to some hidden agenda of its own. I think that's the important point.

CROWLEY: One of the things obviously that fueled this -- yes, it was Tunisia, an example of something that could be done by a single man. Yes, this was a brutal dictator that they wanted to get rid of. But unemployment, poverty, corruption was really the fuel to this. I mean, that's what brought everybody -- I kept looking at those people in the square thinking, they are going to be disappointed, because the things that really bother them are going to take years.

WALKER: It's going to take years to get the economy really rolling again. They have taken a hit, but it's not that big a hit. People talk about tourism disappearing. Well, after the Japanese attack in Luxor it only took I think three months before the tourism industry was back to where it was before.

Egypt has amazing resilience and recovery capacity. But they are going to have to change the rules of the game so you don't have crony capitalism, you don't have people ripping off the state. They have got to really come clean on the corruption side.

CROWLEY: Do you think that there is a way to keep Egyptians day to day happy, content until you can put together democracy? I think that's the big fear, is it not?

NEGROPONTE: I agree about the risk of disappointment and that's a fairly high risk. And it certainly wouldn't be the first time that that has happened, but it's also an opportunity. There really is an opportunity here to reinvigorate the economy. It may be an opportunity for some other Arab countries like the Gulf States and Saudi Arabia to come forward with some kind of rehabilitation package for Egypt.

Egypt is poised actually, has been poised for the last few years for dramatic economic growth: its good position towards Europe, its large population, its intelligent, well-educated people. So -- I mean, there are opportunities out there if the country can just calm down enough and get its act together. CROWLEY: Who's running the place? I realize it's a military council, but doesn't there have to be one person somewhere that goes, yes, no, go this way?

WALKER: Well, Field Marshall Tantawi is the man who has assumed the role of saying yes/no, but he's not going to operate on a unilateral basis. He's got to reach out both to his council, the supreme council. They are going to have to reach out to more people than that, they're going to have to bring in civilians very quickly to keep some kind of semblance of movement for the people. And, you know, Field Marshal is a very cautious, conservative guy.

But in my talks to him before, he's never shown any indication of wanting to be the top boss.

CROWLEY: So where is the U.S. in all of this now? I mean, I got the feeling talking to a couple people in the administration over the weekend that they are kind of watching like the rest of us in some ways thinking, you know, which way will this going to go? They are trying to be encouraging without intervening. You know, it's another tight rope you have to walk because you don't want to look like you are pushing something on them.

What is our best stance now? Is it just to stand back and say let us know what you need?

NEGROPONTE: Well, I have difficult visualizing us doing that given our behavior during the last two, three weeks.

I mean, I have a feeling we'll play a fairly proactive role. I think it would be good to restrain ourselves, but I think we're going to play a role of holding the military's feet to the fire so that it continues to be responsive to these popular demands, revise the constitution, make it possible for more people to run, make it possible for multiple political parties to thrive sort of all the while at the same time making it clear that it's up to the Egyptians themselves to decide.

CROWLEY: I want to talk about what's at stake with U.S.-Egyptian relations and the basic fight against terror, but I want to take a break. So if you'll stand by with me, up next we want to go to CNN's Fareed Zakaria and we're going to get his take on the future in Egypt.

Fareed, I know you have just wrapped up a couple of important interviews, one of them with a man who has become, really, the face of the protesters. What did you learn?

FAREED ZAKARIA, CNN: Mohamed ElBaradei -- actually, it was interesting. I think there is some unease among the opposition groups that they have gotten their first go, which was getting rid of Mubarak, but this wasn't a personality thing. They wanted to get rid of the regime, the military dictatorship. And they feel that the military, which is now in place with absolute powers, really, is not being clear about exactly what the road map to democracy is.

And what ElBaradei told me was, unless, by Friday, they have a fairly specific road map for democracy and a road map for a transitional government, a co-management of the process, the protests will begin again on Friday.

CROWLEY: Well, that seems, like, a little problematic. Does he think that, actually -- I mean, given this is a government that's been entrenched for three decades, that it is something that they can actually do by Friday?

ZAKARIA: I think what he's looking for are signs that the government realizes this is a transitional period; in other words, some kind of government of national unity or some, as he puts it, co- management of a process so that it's not entirely up to the military.

Then he wanted a series of more specific things, some of which, by the way, the military have just agreed to. As we've been having this conversation, there is a fifth military communique out in which the military does say that they are going to dissolve parliament; they are going to hold new elections, though no timetable for when those would happen.

They explained that the Constitution is now no longer active, which makes sense because the way Mubarak left was, you know, kind of, unconstitutional. He -- he wouldn't normally have handed power to somebody else, the speaker of the national assembly.

So some of that has been clarified, but the crucial issue of when these elections are going to be held, what the sequence is, parliament first then presidential elections or the other way around, none of that has been clarified.

And I think the protesters are just uneasy at the prospect that they have lost Mubarak but they've gained a military dictatorship.

CROWLEY: Fareed Zakaria, we will be joining you at the top of the hour. Thanks so much.

We want you to stay tuned for Fareed Zakaria. It is at the top of this hour. We have more with our ambassadors, though, when we come back.

(COMMERCIAL BREAK)

CROWLEY: We are back with Edward Walker and John Negroponte, two men with long resumes steeped in this region and elsewhere.

It seems to me that there are questions and analysis that come out now that show us two sides. So here's what -- here's what I'm hearing. I want to get you all to comment.

Other Arab allies in the region, Saudi Arabia, Jordan among them, have been upset with the U.S., feeling that they cut Mubarak off and pushed him off a cliff. So they will either step back because they're upset with the U.S., or they are now prone to work more with the U.S. on putting more democracy, if that's the word -- or making their societies freer.

What -- how are our good allies in that region going to react to this?

WALKER: Well, you've got -- King Abdullah of Saudi Arabia is quite upset. I think there -- he genuinely thought that we pushed Mubarak off a cliff. And, obviously, these other guys are concerned about what will happen if their people start to get anxious. And what will our position be?

So there's a little bit of mending fences that's going to have to take place and reassurances that have to be taking place.

I don't think the problem is so great in Jordan. His problem is his own people. He's got to look out for that first.

CROWLEY: I did hear from -- on both sides of this diplomatic equation that the Saudis were quite upset and they said it says something about whether you will stand by your friends, the way you've treated Mubarak, that that was the message that they sent.

Is that permanent damage, or...

NEGROPONTE: I don't think it's permanent damage, but I also think it's, sort of, a classic issue when you have a transition from an authoritarian regime to some -- some kind of change. We've seen this happen in the past as well.

But it's going to call for more diplomacy between us and the region, the entire region, and I think that the relationships will survive.

WALKER: Yes, it's also -- it's also going to require one message coming out of the United States. And we've had just too many different voices coming out and indications of differences within the White House or within the State Department and so on. So we need to get the message straight.

CROWLEY: And what do you think that message is now?

WALKER: Look, we're in favor of what's happened, Mubarak out. We're in favor of a constitutional government, reformed constitutional government. We're in favor of free and fair elections. All those things are still there.

CROWLEY: But I have had administration officials say to me, look, the president was very clear from the beginning that he wanted -- that he believed in the rights of the protesters to be there and that he wanted the Mubarak government to open up to their demands and to listen to them and that there wasn't any kind of cacophony coming out of the White House or coming out of the State Department, that everybody was in synch because the policy was very clear from the beginning. NEGROPONTE: But I think, in addition to what Ambassador Walker just said, yes, we favor these development and we're supportive, but at the same time we're not naive. We weren't born yesterday. We know these things take time and that it's a long-term process and that, while a democratic and representative government may be the long-term goal, we in fact think that democracy and representative government is probably the best way to assure long-term stability of a country and of a region. But we realize it's going to take time and it's going to happen in different ways.

CROWLEY: Stability in the meantime in the middle.

NEGROPONTE: There is always that risk.

CROWLEY: Let me ask you about a couple of other things. One is, there is one theory that this was a great victory for al Qaeda. There is another theory that, no, this was devastating to al Qaeda, because first of all the Muslim Brotherhood, the most organized group in Egypt and al Qaeda are enemies. And second of all, what this has shown is that by peaceful means you can take over a government, that it doesn't need to be by al Qaeda means.

Did al Qaeda win or lose in all of this?

WALKER: Al Qaeda lost on this, because al Qaeda has basically said all along that this is a situation that can't be fixed by the people. It has to be fixed by violent revolution and we represent violent revolution. And that's been their pitch to the Arab people. Now they have been shown to be, you know, without any basis for their complaints.

CROWLEY: Let me ask you about Israel. And that is there is one school of thought that says, well, now because of uncertainty they are going to be less willing to engage in the peace process with the Palestinians. There is another that says, no, they will be more willing to engage because they have seen, you know, what's happened in Egypt. So, are they more or less willing?

NEGROPONTE: Well I'm not certain, but I think Israel certainly must take some reassurance from the fact that the Egyptian military have reaffirmed their commitment to their international -- the country's international agreements. Read: commitment to the Arab- Israeli peace process. So, I think that's good.

CROWLEY: And let me ask you about U.S.-Egyptian intelligence information-sharing. One theory, well, you know, because this will be a new government that might not be able to or actually be as friendly to the U.S. as Mubarak was, we are losing a key intelligence partner here who helped with al Qaeda, who has helped with Iran, who has helped in Gaza. Or because it's a democracy and we are going to share these values, it will even be of greater help.

NEGROPONTE: Well, I mean, let me put it this way the most effective and best intelligence cooperation we have around the world is with the most democratic countries. There is a group called the five eyes which consists of the United States, Australia, the United Kingdom, Canada and New Zealand. That's where we have our best intelligence cooperation. I rest my case.

WALKER: Yes, but also keep in mind the Egyptians have a vested interest in some of the same things we have a vested interest in and that is to deter radicalism in the Middle East and so there will be strong incentive for the intelligence community to continue cooperation.

CROWLEY: Edward Walker, John Negroponte, thanks for traveling this road with us. I really appreciate it.

Up next, the upcoming showdown in Washington over the president's new budget.

(COMMERCIAL BREAK) CROWLEY: President Obama submits his 2012 budget to Congress tomorrow and the White House promises major cuts. That may depend on your definition of "major." As part of his package the president will call for a five-year freeze on discretionary spending, which is to say programs the federal government is not required by law to fund. Some programs will get more money, some less. On the less list -- a $350 million cut in community service programs, $300 million for local housing and economic development programs, and a $125 million cut for environmental cleanup. All told, the freeze would save about $400 billion over ten years. That's real money except the u.s. debt is $14.1 trillion -- with a t. That is jaw-dropping money.

Critics say the problem is discretionary programs really are not really the problem. Alan Simpson is co-chair of the president's debt commission.

(BEGIN VIDEO CLIP)

ALAN SIMPSON, CO-CHAIR, DEBT COMMISSION: I'm waiting for politicians to get up and say there is only one way to do this, you dig into the big four: Medicare, Medicaid, Social Security and Defense. And anybody giving you anything different than that, you want to walk out the door, stick your finger down your throat and give them the green weenie.

(END VIDEO CLIP)

CROWLEY: Which is to say what's blowing up the budget is in large part the programs the federal government is required to fund -- up next, White House budget director Jacob Lew.

The president tomorrow puts out the fiscal year 2012 budget. People are already lost. Why are we doing 2012 in 2011 and all of that.

So let's get down to the basic question, who's going to get hurt in this budget?

LEW: You know, Candy, this is a very difficult budget. The budget saves $1.1 trillion over the next 10 years in domestic spending. It reduces, as you said in your introduction, $400 billion, which would bring us down to the smallest government as a size of the economy since Eisenhower was president.

The challenge we have...

CROWLEY: At what cost?

LEW: The challenge we have is to live within our means but also invest in the future. As the president said, we have to out-educate, out-innovate and outbuild in order to compete in the next century.

In order to do that, we have to make tough tradeoffs. And you listed a few of the examples. There are many, many more. There are scores of programs that are being reduced.

And I think it's important to note that we're beyond the easy, low-hanging fruit to say that it's all waste and fraud. We're reducing programs that are important programs that we care about, and we're doing what every family does when it sits around its kitchen table. We're making the choice about what do we need for the future? And I think the budget does a very good job of it.

CROWLEY: So, such as? Tell us some more...

(CROSSTALK)

CROWLEY: ... where are the cuts?

LEW: I can tell you that in -- even where we invest, we've had to make some tough decisions for cutbacks.

So in education, we invest very seriously to make sure that 9 million students can go to college using Pell grant, to make sure that K-12 education -- we have 100,000 new teachers who are trained and experienced in science, technology, engineering and math.

But we also have cutbacks. In order to pay for the Pell increase, one of the things we're doing is saying there will be no more Pell grants for the summer; they will be for the school year only. In the area...

CROWLEY: No summer school Pell grants from the government?

LEW: Yes, and in the area of graduate student loans, interest will start building up while students are in school.

CROWLEY: Now they graduate, and then the interest starts?

LEW: Correct. Right. All told, there's $9 billion in those proposals this year, and that will make it possible to make sure that 9 million students can go to college.

CROWLEY: So you have said in an editorial you wrote that the budget is an expression of our values and aspirations.

So if I look at this what we call discretionary spending, things we don't have to spend on, you want to cut back community development block programs. That creates jobs in communities; it helps them with infrastructure, that kind of thing. Home heating assistance; education, as you just mentioned. You're also going to do -- the Great Lakes Restoration Fund Initiative is getting a pretty healthy cut in what they get from the feds, eight states involved, in trying to keep the Great Lakes economically viable.

What does that say about our values and aspirations?

LEW: Well, what it says, Candy, is that we really do have to do what every American family does; we have to start living within our means.

Our budget will get us, over the next several years, to the point where we can look the American people in the eye and say we're not adding to the debt anymore; we're spending money that we have each year, and then we can work on bringing down our national debt.

You know, the notion that we can do this painlessly is -- it's not possible to do it painlessly. We are going to make tough choices.

The question is, do we do it in a way where, while we're making the tough tradeoffs, we're making the critical investments so that we have a future that creates jobs for the American people so that we can outcompete in the world of the 21st century.

CROWLEY: Here's the problem, I guess. If you are a graduate -- let's take one of your examples. You're a graduate student; you are, right now, getting loans. You don't have to pay those loans or any interest on them until you graduate. But now you have to pay -- or it accumulates, I'm assuming -- you have to pay interest beginning on day one of grad school, and that makes it so that you can't go to grad school.

LEW: Well, let's just be clear. Interest will build up, but students won't have to pay until they graduate. So it will increase the burden for paying back the loans, but it will not reduce access to education.

That's, I think, part of how you can responsibly have a plan that deals with the challenge of solving our fiscal crisis, getting out of the situation where the deficit is growing and growing, but also investing in the future.

We have a responsible budget that will cut in half the deficit by the end of the president's first term. It deals with all parts of the budget, and it's a plan which we look forward to presenting it to the Congress and getting a bipartisan discussion going on how to achieve it.

CROWLEY: The president had a debt commission. They put out a big long report on how to get out of this -- of the debt -- not the yearly deficit but the accumulative number that we are in the red, which is in the trillions, $14.1 trillion, I believe, is where we are. And yet very little of that is reflected in this budget.

Why was there a debt commission to begin with, since everybody seems determined to ignore what you heard Alan Simpson call the big four, Medicare, Medicaid, Social Security and defense. I know there are cuts in defense, but the commission found many, many more. Why even bother if this document isn't going to reflect it?

LEW: First, I would say that the commission did a very important job. It framed...

CROWLEY: But everybody, kind of, says that.

LEW: It framed a discussion which is very much influencing how everyone working on the budget going forward thinks about it. There's more on the table, more that's open for the kind of civil discourse that we need in order to make the tough decisions.

In our budget, there are many, many ideas that one can look to the commission where they took leadership, medical malpractice, corporate tax reform, pay freeze for the federal government. There are many, many provisions in our budget which were part of what the commission proposed.

I think it's a mistake to say that the commission's report did not have an impact. It had a very significant impact.

CROWLEY: But, basically, they say, look, discretionary spending, great; we should cut back plenty of things, but what about Medicare?

And where are you on -- where are the big ideas for the big programs that suck money out of the economy? LEW: Well, I think, if you look at the entitlements, we have some important policy in this budget. There's a provision that, for the last number of years, Congress has passed on a bipartisan basis to make sure that the payments to doctors under Medicare don't get cut. The problem is, if the payments to doctors are cut, their willingness to treat Medicare patients would go down.

CROWLEY: That doesn't cut the budget, though.

LEW: Well, when you put it on the national credit card and you say we're not going to let those changes take effect, it increases the deficit.

CROWLEY: But is that the big kind of thing that they talked about on the debt commission?

There's nothing about Social Security.

LEW: We have $62 billion of savings to pay for dealing with that provision in Medicare over the next two years. That's real money; $62 billion is real money.

CROWLEY: It is, but...

(CROSSTALK) LEW: In terms of Social Security, let's also be clear that Social Security is not contributing to the short-term debt. Social Security is a separate issue. It's something where we have an obligation to the American people to make sure that Social Security is sound for this generation and the next generation. And the president said he wants to work on a bipartisan basis to deal with Social Security.

CROWLEY: But there's no -- there's no big ideas, I guess, no big, OK, we're going to bite the bullet here; Medicare needs to be means-tested; Social Security -- you know, the amount of income that you pay Social Security taxes on should go up. There's nothing like those big things that really...

LEW: Well, I disagree with that. The president took office and we were on a path where the deficit was growing over 10 percent of our economy. Now, he's put forward a plan that will bring it down in the middle of the decade to a sustainable level.

That is a big idea. Because, as every family knows, if you're having trouble paying your bills, you have to stop adding to the balance. And he has a plan that would do that. He's called it a downpayment and it's a responsible downpayment, and he's extended his hand to work on a bipartisan basis to deal with the long-term problems. I think we have to get that accomplished in the next few years.

CROWLEY: I need a yes or no from you about the 2011 budget, which still hasn't been passed. House Republicans believe they can take $100 billion out of that, right now, for this bill that goes until next October.

Is that doable -- not the way they want it. Is it even doable to take $100 billion out of that budget?

LEW: Candy, we have a responsible plan that's before Congress. We look forward to working with Congress. We think that there is a way to reduce spending. We all agree we need to reduce spending...

CROWLEY: By $100 billion?

LEW: ... and we have to do it in a way that's consistent with our values and invests in the future. We look forward to working with the Congress on that.

CROWLEY: $100 billion, yes or no?

LEW: We look forward to working with Congress.

(LAUGHTER)

CROWLEY: Jacob Lew, thank you so much. Appreciate your time.

LEW: Thanks for having me.

CROWLEY: Thanks for watching "State of the Union." We hope you will join us next week when our guest will be defense secretary -- former defense secretary Donald Rumsfeld. I'm Candy Crowley in Washington.